Sunday, February 04, 2007

Understanding Economics: Property

An essential feature of any free market economy is the existence of property rights. Economics can be used to analyse the concept and consequences of property.

Almost every object on Earth is the property of some person or entity. Unowned objects are rare these days. Most of that which is unowned is not scarce. In other words, there is more available than what people demand at zero price. Air and sea water are examples.

Several important distinctions need to be made here. One is between objects that are owned, and unowned but used, in what is sometimes called "collective ownership." Another is between private property and government property. A third is between property rights and the lack thereof.

It's possible for people to use something without owning it, that is without the right to exclude others from its use. What sort of incentives does this situation entail? The typical example of such a situation is the "tragedy of the commons." The commons were unowned land where English farmers could graze cattle. When something is available for free, a person's natural reaction is to use as much of it as possible. So it was with the commons, and they ended up in bad condition due to overgrazing. People were certainly capable of maintaining land, but there was no good reason to do so, because most of the benefit of any one person's efforts would go mostly to others.

In contrast, land that was owned was well-maintained and much more productive. Owners had a stake in its continued productiveness, so they took the necessary steps to avoid overgrazing. Ownership leads to much better use of resources than non-ownership.

Government ownership is not the same as "collective ownership." The government is an organization composed of some people, and not others. Some government property is mostly open to the public, while much is restricted to a few people. What makes government a unique institution is its ability to take others' property by force. This means that government does not have the same incentive to use resources wisely. It doesn't suffer losses from its mistakes because it can make them up by taking the property of others. Thus government ownership of property is necessarily wasteful compared to private ownership.

Property rights are a legal or moral claim to current and future use of property. This means that not only do you have property now, but that nobody can take it away from you. What incentives does this create? Property rights greatly reduce risk. Any successful economy requires investment. But investment is irrational if the rewards are likely to be taken away from you. There's not much point in planting a field if others will harvest it. There's not much point in owning land or starting a business if thieves or the government could take them from you at any time.

There are several ways that property rights can be protected. Property owners can defend their property by force. Tradition can recognize property rights and their defense. And government can guarantee property rights. Of course, can is not the same as will.

Peruvian economist Hernando de Soto has shown that many poor people in the third world don't legally own their property, even though some have used it for years. They can't make investments and improve their fortunes because of this uncertainty. The single most important thing that can be done to improve these countries' economies is to guarantee property rights. Government still takes people's property through taxes, but at least if it does so predictably, people can make investments with less risk.

Property rights are important even to those who have little or no property. They facilitate the creation of new products and jobs that benefit the poor.

While America has protected property rights well for the most part, property rights are threatened by several government policies. The use of eminent domain has traditionally been restricted to a few government projects, but in recent years, more government units have taken to using it to aid private developers. Some environmental regulations drastically restrict the use of property, and hence drastically reduce its value, without formally taking away its ownership. Such policies can only have the damaging effects described above.